The Money Multiplier: Practice Problems and Solutions

Problem 21. Which of these is a valid definition for the money supply M?

(a) M = CU + R, where CU = currency, and R = bank reserves
(b) M = CU + D, where CU = currency, and D = bank deposits
(c) M = D + R, where D = bank deposits, and R = bank reserves
(d) M = CU/R, where CU = currency, and R = bank reserves
(e) M = CU/D, where CU = currency, and D = bank deposits
(f) M = CU*R*D, where CU = currency, R = bank reserves, and D = bank deposits

Solution 21. The correct answer is (b): M = CU + D, where CU = currency, and D = bank deposits

Problem 22. What is a name given to the sum CU + R, where CU = currency and R = bank reserves?

(a) Money multiplier
(b) Bank deposits
(c) Reserve requirement
(d) Money supply
(e) Savings
(f) High-powered money
(g) Money without power

Solution 22. The correct answer is (f): High-powered money. The equation for high-powered money is H = CU + R.

Problem 23. What is the formula for the money multiplier, where cu is the currency/deposit ratio and re is the reserve/deposit ratio?

(a) mm = 1/re
(b) mm = 1/cu
(c) mm = (cu + re)/(cu + 1)
(d) mm = (cu + 1)/(cu + re)
(e) mm = (cu + 1)(cu + re)
(f) mm = cu + re
(g) mm = cure

Solution 23. The correct answer is (d): mm = (cu + 1)/(cu + re)

Problem 24. The amount of currency in Assumptionland is 430,000. The amount of bank deposits in Assumptionland is 4,310,000. The amount of bank reserves in Assumptionland is 3,400,000 What is the money multiplier in Assumptionland?

Solution 24. The formula for the money multiplier is mm = (cu + 1)/(cu + re), where cu = CU/D, and re = R/D. Here, CU = 430000, D = 4310000, and R = 3400000. Thus,

cu = CU/D = 430000/4310000 = cu = 0.0997679814 and re = R/D = 3400000/4310000 = re = 0.788863109

So mm = (cu + 1)/(cu + re) = (0.0997679814 + 1)/(0.0997679814 + 0.788863109) = mm = 1.237597911

Problem 25. Which of these factors directly affect "re" - the reserve/deposit ratio in the formula for the money multiplier? More than one answer may be possible.

(a) The printing of additional paper money bills by the government.
(b) The reserve requirement.
(c) Banking regulations such as federal deposit insurance.
(d) Transactions demand among consumers.
(e) The banks' tradeoff between profitability and safety.
(f) The annualized rate of GDP growth.

Solution 25. The following factors directly affect re:
(b): The reserve requirement.
(c): Banking regulations such as federal deposit insurance.
(e): The banks' tradeoff between profitability and safety.

Choice (d) is not a correct answer but is worth mention: transactions demand among consumers directly affects cu but not re.

See Mr. Stolyarov's complete index of Intermediate Macroeconomics Problems and Solutions here.